Since the inauguration of automated trading in hedge fund management, the global hedge fund market has taken a crucial turn. As hedge funds primarily rely on different trading algorithms, the complex algorithms of automated systems have increased the implementation of automated trading in the hedge fund industry.
Consequently, in the growing environment, the top hedge funds severely depend on automated trading strategies and algorithmic trading to ensure an extensive return after the investment. However, there are a diverse number of different algorithms and methods hedge funds implement.
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In this article, we will discuss and highlight the different types of algorithmic trading strategies the global leading hedge funds are using to make a fortune.
What Is a Hedge Fund?
A hedge fund is an investment partnership that processes the fund through different strategies, investments, or trades in complex markets. In hedge funds, the investors are primarily institutions, and they rely on complex techniques and symmetric calculations to run the portfolio and manage risk.
 According to Statista, the total assets of the global Hedge Fund management industry is about $3.8 trillion, with around 1000+ Hedge Funds worldwide. Since 1997 the industry started booming and has kept a steady flow till date.
What Is Algorithmic Trading?
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Algorithmic trading, also known as Automated trading or Quantitative trading, uses a computing system to calculate the probability of profitability of different financial instruments and implement the likelihood in actual time trading. These computer systems take all kinds of market information as input and process it, examining and comparing it with historical market data.
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A human brain can process an inadequate amount of data simultaneously, but a computing system can open the gate of infinite calculations at the same time interval. Hence, Algorithmic trading has become the core tool in monitoring the financial instruments and balancing index funds, scalping, arbitrage, pairs trading, mean reversion, and many other systemic improvements.
Different Types of Algorithmic Trading Strategies for Hedge Funds
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Momentum StrategyÂ
The Momentum Strategy primarily executes the pre-programmed decision by the manager or the programmer. The core purpose of the algorithm is to detect the spike moment and implement the decisions regarding the specific moment. Among all algorithmic strategies used for different hedge funds, the Momentum Strategy is the most popular.
Mean Reversion StrategyÂ
The Mean Reversion strategy focuses on the long-term average price of the stocks. That’s because the market is reverting monotonously. A price may go low or can go too short occasionally regarding the market atmosphere. However, eventually, the price comes back to its average. Therefore, buying low and selling at the average price assures profitability.
Arbitrage Algorithm
Arbitrage Algorithms are advanced complex algorithms that detect price discrepancies in different markets and profit from buying and selling simultaneously. Likewise, it finds the price difference between two different markets to buy and sell to generate profit.
These opportunities appear for limited time windows and require simultaneous buying and selling to turn such opportunities into profit. If you use hedge fund management software like MetaTrader 5 for hedge funds, you can access 80 exchanges and liquidity providers worldwide to sneak peek to utilize Arbitrage Algorithm.
Market Making Strategy
Market-Making strategies function as liquidity providers in the market. For example, supplying regular buy and sell orders in the market keeps a specific instrument more liquid than its average. Market-making strategy keeps the buying and selling price stable and decreases the spread between buying and selling price.
Basket Trading
In Basket Trading, managers buy multiple securities shares and track their entities to measure their potential return. Instead of investing the entire sum on a particular claim, the weighting gets divided equally into blocks of shares. Because of the automated parallel trading opportunity, it is relatively more reliable than other tradings.
High Frequency Trading
High-Frequency Trading (HFT) is one of the most used automated trading strategies for hedge funds. That’s because these kinds of trading occur based on studying marketing behaviors and happen as fast as possible, often in a fraction of a second. Therefore, such automated trading requires expensive infrastructures to process faster data analysis and quick reaction time. Notably, the trading systems with a speedier execution rate are more profitable than the slower ones.
Bollinger Band Algorithm
Bollinger band algorithmic strategy functions based on three different bands, Lower, Middle and Upper. It generally determines the entry and exit point of a trade. Likewise, it often figures out the overbought and oversold conditions for an instrument. Bollinger Bond functions from the middle band, and if it crosses others, executes some orders.
Relative Strength Index (RSI)Â
The relative Strength Index (RSI) strategy is an algorithm dependent on the value of the RSI index. For example, 70 is the indication of RSI overbought, and 30 is the indication of oversold. However, RSI can give wrong signals, and the volatile markets can break the barrier of 70/30 calculation.
Statistical Arbitrage
Statistical Arbitrage indicates the simultaneous buying and selling of multiple portfolios that are traded for short periods. Such trading algorithms compose portfolios and reduce risk. However, it is hugely reliant on computer models and data analysis. Also, it is one of the most meticulous algorithmic trading strategies.
Parabolic SAR
The Parabolic SAR trading strategy predicts and identifies the market trends and takes decisions regarding the trading assets in similar conditions. Likewise, it forecasts the potential continuations or reversal of an underlying market. Similarly, a relapse can turn a bullish market into a bearish market or a bearish market into a bullish market. However, funds can use this algorithmic trading strategy for both long times and short times.
CCI
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The Commodity Channel Index (CCI) is a trading
algorithm that compares the current price and the historical value price. When
the value of CCI is over 0, it indicates the price is above the historical
average. On the other hand, it indicates below 0, only if the price is below
the historical data.
Summary
All of the distinctive hedge funds have their trading experts who operate trading algorithms. In most cases, the hedge funds make a great amount of profit doing Automated trading, and mostly the funds put their trust in different computer software and algorithms. However, it’s wise for all the companies to test carefully before going on full throttle with an algorithmic trading strategy.
